Let’s try again and answer the question, “how much money can I make from Forex trading?”
How do you determine what is the minimum acceptable earnings by day trading? What is the appropriate earnings target? Is it 50% , $2500 (per month), $50,000 per year or equal to or greater than Dow Jones or S&P’s annual return? Should your returns be based on benchmarks set by the biggest investors?
Unrealistic Return target: I want to earn 50% on my $1000 account per month!
So, how on earth did I reach to that conclusion! Well, look at the ‘median annual income’ per Canadian is $27,600.
And how industry’s top investors are faring in this game.
Are you ‘day trading’, ‘swing trading’ or ‘position trading’ for ‘income’ or you are trading for ‘wealth’? Different options present different game plans and results. Because, every trader has different ‘Trading Variables’, that will yield different trading results, choose your trading variables from the following numbers:
- Trading Expectancy : My expected return on every dollar I risk, for trade.
- Trading Frequency: Number of trades I take is 20 per month or 140 trade per year.
- Account Size (Capital): Dollar size of my capital account, from $10k (1% is $100) to $1 M (1% is $10,000).
- Risk Tolerance, (% of capital per trade it is $ amount): My maximum ‘per trade’ dollar amount is 1% of capital (1% of 50K is $500). Some traders also call it bet size.
- Withdrawals: If, it is my income account, I may be withdrawing some percentage periodically.
- Trading Strategy: (There are so many of theses, to mentioned here!)
Get real, and do the math to get ‘the most important‘ trading variable:
if, I do 20 trades per month out of which 12 winners and 5 losers and 1 cancelled trades. Now, my win percentage is (12/20)*100 = or 60%. (if cancelled trade is accounted then 12/19 x 100=63%). On my losses on 5 losing trades were $1500, and average loss is $1500/5 = $300.
Those 12 winning trades made me a profit of $6,000, then; My average win=$6,000/12 = $500.
Expectancy= (1+ Win/Loss) x P – 1 = 1+500/300 x 0.60 -1=1.60-1=60%
Win is ‘average win’ and loss is ‘average loss’ size in dollars and ‘P is winning percentage’, which is positive 60%. In another words every 1 dollar I trade, I can expect 60 cents return.
Let me populate the formula to get yearly returns:
Trading expectancy * Trade Frequency * Risk Amount per trade = 0.60 * 140 * $500 = $42,000 (annually)
[Trading expectancy * Trade frequency * Risk amount]($42,000) / Account size($50,000) =$42,000/$50,000= 84%, This means expected average of 84% in a year year.
Money management is arguably the most important concept that a trader needs to master in Forex. Strict money management rules, such as using Stop Loss levels, managing the risk per trade, risk-to-reward ratios, and position sizes, need to be rigorously followed by all traders who are serious about being successful in the long run. Even the best trading strategy in the world won’t be of much help without sound money and risk management practices, making this one of the first lessons that newcomers to the market should learn.
Money management is the way you manage and oversee the risk of your trades in order to increase your profitability. We’ll cover the main aspects of money management in this article, including risk-to-reward ratios, risk per trade, drawdown and maximum drawdown on your trading account, position sizing, and more. Make sure that you’ve understood all these concepts before moving on as they will form the cornerstone of your trading career.
Risk Tolerance: Risk-to-Reward Ratio (RRR) of my trades
Money Management is the risk-to-reward ratio of trades, risk is relative to the potential profit of a trade. Know in advance, at which price level to Enter the market, place your Stop Loss and Take Profit Target. Exit targets determine the RRR of the trade.
Example:If you place your Stop Loss at 25 pips below the Entry Price, and your Take Profit 50 pips above the entry price for a Buy (Long) Position, the Risk-to-Reward Ratio of your trade is 1:2.
RRR of 1:1 mean that I am risking the same $ amount as the potential gain of the trade,1:2, 1:3 or more mean that the potential gain is two or three times higher than the risk of the trade. Higher RRR enables traders to digest more losing trades than winning ones and still break even or even profitable! RRR 1:3 means two losing trades and one winning trade will still a profitable result.
The golden rule of money management: never risk more than 1-2% of your trading account on a single trade. Additionally, cumulative risk of all open trades should not exceed 5% of total trading account balance. New traders should not risk more than 1% per trade until you get more familiar and comfortable with trading.
Drawdown and maximum drawdown MDD: Drawdown is reduction of your trading account balance after a losing trade or series of losses. It’s the distance from the most recent peak in your balance to the most recent trough.
The maximum drawdown (MDD) is the maximum loss from a peak to a trough of a portfolio, before a new peak is attained. Maximum Drawdown (MDD) is an indicator of downside risk over a specified time period. It can be used as a stand-alone measure or as an input into other metrics such as “Return over Maximum Drawdown” and Calmar Ratio. Maximum Drawdown is expressed in percentage terms and computed as: (Trough Value – Peak Value) ÷ Peak Value
Realistic earning: target of 5% per month on $50,000 account size, would get me $2500 per month or $30,000 annually. Most important number is your account dollar size.